Understanding the Payroll Issues of the Public Sector

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By Dave Foxall

Sector-Specific Factors in Government Payroll Operations

The overall government job market may well be unique. On the one hand, we have huge reductions in the number of public service jobs under the current administration, and on the other, there is a growing demand for the features often associated with government jobs (e.g. employer stability and solid benefits packages). Ironically, both of these conflicting factors are direct responses to the shaky national and global economies of recent years. Such trends inevitably have an impact on payroll and benefits management, particularly in terms of the role that management can play in attracting and retaining talent. That said, one predictable result of the drive to reduce public service costs at local, state and federal levels is the increasing automation of HR and payroll. In fact, according to the CedarCrestone HR Systems Survey, the adoption by the public administration sector of automation technology and employee self-service functions for basic HR and payroll stands at 88%. Although this is below the worldwide average of 93%, CedarCrestone’s three-year outlook prediction firmly states, “More organizations in late-adopter industries—including public administration, higher education, and even healthcare—that are not yet adopting self service will begin to do so.” With the automation of government payroll on the rise, there is no shortage of software vendors and payroll outsourcing providers proclaiming their public service prowess. However, any product or service should at the very least be able to tackle the following specific issues.

Government Payroll Issue #1: Increasing Contingent Labor

Much like the payroll needs associated with the manufacturing industry, the need to keep payroll costs (and therefore headcount numbers) down coupled with the necessity to replace at least a proportion of the impending tidal wave of retirements caused by current demographics means that many organizations and agencies are looking for more flexible and non-traditional solutions. The use of temporary contracts is giving rise to an increasing contingent element in the overall public workforce. As the Oracle white paper, Successfully Executing and Managing a Contingent Workforce Strategy states, “Non-traditional employment arrangements are on the rise. As has been the trend for decades contingent labor models are going to increase, however over the next few years and coming decades this trend will increase rapidly.” This is to be expected when the economy is in recovery but Oracle and other employment analysts believe this will be an ongoing labor feature on a global level. The UK’s AccountancyAge predicts, “Outsourcing will become increasingly popular as companies re-build in what is a wholly changed business landscape. We also expect increased interest from the public sector as they work to streamline and reduce overheads.” From the payroll management point of view, contingent workforces bring in ‘wild card’ factors around decentralized hiring processes, variable rates of pay, questions over just who is the ‘employer of record’, unreliable and patchy data for payroll reporting and analytics, and potentially complex legal compliance and tax classification issues.

Government Payroll Issue #2: Taxable Fringe Benefits

Given that the public service payroll bill is ultimately covered by the taxpayer, a greater degree of regulation and control over fringe benefits received by government employees is to be expected. To help with this, the IRS publishes clear guidelines of which any public employer (and its payroll department) needs to be aware. According to the IRS’s Taxable Fringe Benefit Guide, “A fringe benefit is a form of pay (including property, services, cash or cash equivalent) in addition to stated pay for the performance of services.” The general rule is that fringe benefits are taxable (and therefore subject to Federal income tax withholding on the part of the employer) but the Internal Revenue Code (IRC) does provide for some excluded categories; namely:

Partially taxable – a portion of the benefit is excluded and the rest is taxable; for example, the public transportation subsidy under section 132.

Tax-deferred – the benefit is not taxable when received, but is subject to tax later; for example, employer contributions to an employee's pension plan may not be taxable when made, but may be taxed when distributed to the employee.

Government Payroll Issue #3: Retirement Plan Complexity

Unlike the relative simplicity of the increasingly widespread 401(k) plans in the private sector, public and government sector pension schemes and retirement plans are less straightforward and require specialist knowledge and functionality to manage and automate. There has been ongoing debate for some time over the reformation of public service retirement plans at state level with a degree of pressure for the public sector to follow the 401(k) lead. The Thrift Savings Plan (a component of the Federal Employees Retirement System) is a defined contribution plan for U.S. civil service employees and retirees as well as for members of the uniformed services. It is distinct from, but treated similarly for tax purposes to a 401(k) plan. However, just to complicate matters, the 457 plan (named for the relevant section of the IRC) is a tax advantaged, deferred-compensation retirement plan for governmental and certain non-governmental employers. The key differences from the 401(k) is that first, there is no 10% penalty for withdrawal before the age of 59½ (although the withdrawal is subject to ordinary income taxation), and second, independent contractors may participate in the plan. The debate over both state and federal retirement plans will no doubt continue, in the meantime, any software or payroll provider must be equipped to navigate the current complexities.

Managing Payroll in the Government Sector – Final Thoughts

Like any sector vertical, government and public administration carries certain unique peculiarities when it comes to payroll management and any software or outsourced service must be capable of addressing these issues. The public sector’s increasing use of contingent labor will demand flexibility in existing processes; the higher level of scrutiny of public employees requires a great degree of accuracy and rigor when it comes to fringe benefit classification; and government service retirement plans can be a specialist field of knowledge in its own right. As the rate of payroll automation increases and new software vendors attempt to meet the needs of this particular sector, these challenges must be satisfactorily met.

Unlike the relative simplicity of the increasingly widespread 401(k) plans in the private sector, public and government sector pension schemes and retirement plans are less straightforward and require specialist knowledge and functionality to manage and automate.”